The director of marketing for Starr Computer Company, Megan Hewitt, had the foll
ID: 2561687 • Letter: T
Question
The director of marketing for Starr Computer Company, Megan Hewitt, had the following discussion with the company controller, Cam Morley, on July 26 of the current year:
Megan: Cam, it looks like I’m going to spend much less than indicated on my July budget.
Cam: I’m glad to hear it.
Megan: Well, I’m not so sure it’s good news. I’m concerned that the president will see that I’m under budget and reduce my budget in the future. The only reason that I look good is that we’ve delayed an advertising campaign. Once the campaign hits in September, I’m sure my actual expenditures will go up. You see, we are also having our sales convention in September. Having the advertising campaign and the convention at the same time is going to kill my September numbers.
Cam: I don’t think that’s anything to worry about. We all expect some variation in actual spending month to month. What’s really important is staying within the budgeted targets for the year. Does that look as if it’s going to be a problem?
Megan: I don’t think so, but just the same, I’d like to be on the safe side.
Cam: What do you mean?
Megan: Well, this is what I’d like to do. I want to pay the convention-related costs in advance this month. I’ll pay the hotel for room and convention space and purchase the airline tickets in advance. In this way, I can charge all these expenditures to July’s budget. This would cause my actual expenses to come close to budget for July. Moreover, when the big advertising campaign hits in September, I won’t have to worry about expenditures for the convention on my September budget as well. The convention costs will already be paid. Thus, my September expenses should be pretty close to budget.
Cam: I can’t tell you when to make your convention purchases, but I’m not too sure that it should be expensed on July’s budget.
Megan: What’s the problem? It looks like “no harm, no foul” to me. I can’t see that there’s anything wrong with this – it’s just smart money management.
How should Cam respond to Megan’s request to expense the advanced payments for convention-related costs against July’s budget?
Explanation / Answer
Now, here Megan is asking Cam to prepay the various expenses that will occur in September month and also asking to show them as an expense in the same month I.e. July.
But if we look at the Accounting principles, I.e. the accrual concept, the expenses incurred should be matched with the period when the revenues have been identified through these expenses.
Which means that the expenses should be shown in the month of September only. However, these various expenses for the month of September should be treated as prepaid expenses and should be recorded as an asset on the balance sheet.
So, yes cash outflows will increase by the prepaid amount but expenses won't.